How do I calculate my portfolio's expected return and risk?

Calculate expected return as weighted average of asset returns; calculate risk using portfolio variance formula considering weights, volatilities, and correlations.

Calculating portfolio expected return and risk involves mathematical formulas that combine individual asset characteristics with their portfolio weights and interrelationships.

Expected Portfolio Return Calculation: Expected Return = Σ(Wi × Ri) Where Wi = weight of asset i, Ri = expected return of asset i

Example: 60% stocks (8% expected return) + 40% bonds (3% expected return) Expected Return = (0.6 × 8%) + (0.4 × 3%) = 6%

Portfolio Risk (Standard Deviation) Calculation: For two assets: σp = √[(w1²σ1²) + (w2²σ2²) + (2w1w2σ1σ2ρ12)] Where σ = standard deviation, ρ = correlation coefficient

For multiple assets, the formula expands to include all pairwise correlations in a covariance matrix.

Step-by-Step Process:

1. Gather Data: Collect historical returns, calculate means and standard deviations
2. Calculate Correlations: Determine correlation coefficients between all asset pairs
3. Apply Weights: Use your actual or target portfolio allocations
4. Compute Results: Use formulas or spreadsheet tools

Key Insights:

• Diversification benefits appear when correlations are less than +1.0
• Risk reduction is most significant when correlations are negative
• Expected returns are simply weighted averages, but risk calculations are more complex

Jürgen Hanssens from Eight Advisory emphasizes that while these calculations provide valuable insights, real-world portfolio management requires considering additional factors like transaction costs and changing market conditions.

For personalized guidance, consult a Portfolio Management specialist on TinRate.